44894 Trade Note July 24, 2008 Global Food Price Crisis: Trade Policy Origins and Options The current spike in global food prices has deep roots in World Trade Policies: The decades of trade-distorting A Taproot of the Crisis policies that have encouraged While several factors beyond trade policy have World Bank inefficient agricultural combined to produce an upward global food Group production in rich countries price spiral, including high energy and fertilizer www.worldbank.org and discouraged efficient prices, depreciation of the U.S. dollar, biofuel production in developing production, changes in food buffer stocks, countries. High-income droughts, and increased world demand (World countries have historically Bank 2008a), the current food crisis has deep protected their domestic historical roots in the distortions of the world producers and subsidized trading system. Governments around the globe Poverty inefficient production--most have intervened in food and other agriculture Reduction & recently biofuels--and markets for decades, particularly through trade Economic dumped surpluses onto global policies. Trade-distorting policies have taken the markets. In turn, developing form of specific and ad-valorem tariffs that are Management countries have often used sometimes linked to quantities of imports (that Department trade and other domestic is, tariff rate quotas); quantitative restrictions or policies to simultaneously tax prohibitions on imports and exports; and and protect their agricultural domestic producer supports and export subsidies sector, with the net effect in for farm products. Countries have also availed many countries of taxing themselves of additional restrictions in the form farmers. Overall, the world of safeguard protection in case of import surges. By Jean-Pierre has suffered from declining Chauffour agricultural prices, The trading system in agriculture is further overproduction in high- distorted and segmented by the existence of income countries, and various trade agreements, whereby preferential underproduction in poor tariff rates and/or market access conditions are countries. This has resulted in offered on a reciprocal or nonreciprocal basis to thinner global agricultural a subset of partner countries. Overall, with markets than otherwise would differing in-quota and out-of-quota tariff rates These notes summarize be the case, more volatility, for agriculture products, many of them specific recent research on global and lower overall reserve or compound rather than just ad valorem, and trade issues. They reflect supply capacity and food with a wide array of preferential bilateral tariffs solely the views of the author, and do not security. in place in most countries, the trading system in necessarily reflect the agriculture is nontransparent, discriminatory, views of the World Bank A first section of this note and highly distorted. Group or its Executive Directors, or the discusses the trade policy countries they represent. origins of the global food Trade restrictiveness across products and price crisis and a second countries tends to show a clear pattern: richer section reviews trade policy countries tend to have higher barriers to trade in options to deal with the crisis. agricultural products. This is a phenomenon that Trade Note 34 TRADE NOTE July 24, 2008 initially emerged in the late 19th century and has publishing annual estimates of producer support been a persistent feature of global trade policy to farmers in OECD member countries. These ever since: the higher the level of development Producer Support Estimates (PSEs) provide a of countries, the lower the overall trade transparent set of numbers that allow monitoring restrictiveness, and the higher the level of trade over time of the extent to which farmers are restrictiveness in agriculture (World Bank being assisted by governments through myriad 2008b). While high-income countries have the direct payments and agricultural market price lowest overall barriers to trade, their overall support policies. Although PSEs have fallen in trade restrictiveness (OTRI) is 43.1 percent for some OECD countries since 1999­2001 (for agriculture as compared to 4.3 for manufacturing example, Japan and the United States), they have (Table 1). This is explained by a relatively high increased in the European Union (EU), the tariff trade restrictiveness (TTRI) (at about 12.4 Republic of Korea, and a number of other percent for agriculture compared to only 1.4 countries (figure 1). Support to producers in percent for manufactured products) combined high-income countries was estimated at US$268 with nontariff measures (NTMs) such as price billion in 2006, accounting for 27 percent of control measures, quantitative restrictions, farm receipts (OECD 2007). monopolistic measures, and technical regulations. NTMs tend to be more prevalent in Figure 1: Producer Support Estimates for high-income and upper-middle-income countries OECD Members, 1999­2006 and to play a less important role in lower- middle-income and low-income countries. For 160 higher-income countries, NTMs account for 140 about two-thirds of total restrictiveness. While 120 NTMs capture policies that do not necessarily 100 have a protectionist intent--product standards USD are a major example--they do have the overall onill 80 effect of restricting trade. Bi 60 40 Table 1: OTRI and TTRI by income group, 20 2006 (percent) Total 0 Yearly Average 1999-2001 Yearly Average 2004-2006 Trade Agriculture Manufacturing European Union Japan USA Korea All-Others OECD High Income 7.0 43.1 4.3 2.1 12.4 1.4 Source: OECD (2007) QUAD 7.1 44.5 4.0 1.9 11.1 1.3 Trade-induced distortions have historically been more pronounced for a number of commodities Middle Upper 13.0 29.3 11.8 4.6 6.6 4.5 currently experiencing a price surge, such as rice. While support based on commodity output Middle Lower 11.8 26.5 10.6 6.5 11.5 6.0 has been shown to be (1) the most distorting of production and trade; (2) a relatively inefficient Low Income 17.7 26.6 16.7 10.8 15.3 10.4 means of increasing farm household income; Note: TTRI in italics; OTRI in boldface. QUAD comprises and (3) most damaging to the environment, Canada, the EU, Japan and the US. some commodities, especially rice, sugar, and Source: World Bank (2008b). milk, continue to be heavily supported through price protection policies and payments based on Agricultural trade restrictions and direct output (OECD 2007). Border measures such as subsidies in high-income countries are a major tariffs not only increase the domestic price of source of support for producers. For 20 years the these commodities but reduce domestic Organisation of Economic Co-operation and consumption, and the resulting impact on Development (OECD) Secretariat has been domestic production and consumption in 2 TRADE NOTE July 24, 2008 the protected markets means that these tariffs the more recent trend toward a more neutral also reduce the world price for these goods, policy stance for agriculture relative to other disadvantaging producers in other countries. sectors of activity is therefore to be welcomed), going beyond this and emulating OECD Developing countries have also put in place members by starting to subsidize agriculture has trade policies that are highly restrictive of trade contributed to further distorting global trade in in agricultural products. All geographic regions agriculture. have policies that are more restrictive of trade in agricultural products than manufactures, Figure 2: Gross Subsidy Equivalents of although the levels of trade restrictiveness in Assistance to Farmers in Developing and agriculture differ widely across regions (Table High-Income Countries, 1960 to 2004 2). Countries in South Asia have on average a (current US$ billion per annum)Source: level of trade restrictiveness in agriculture similar if not higher than that observed in high- 300 income countries. At the other extreme, Sub- 250 Saharan Africa has the lowest level of agriculture trade restrictiveness in the world. 200 DSU 150 Table 2: OTRI and TTRI by developing 100 country region, 2006 (percent) n io 50 Total Trade Agriculture Manufact- uring illB 0 1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99 2000-04 East Asia 11.3 26.6 10.4 -50 5.0 8.7 4.8 -100 Europe and 10.1 25.9 9.0 Central Asia 4.5 10.3 4.0 -150 Latin America 15.0 28.1 13.8 Developing Countries High Income Countries & Caribbean 5.4 6.6 5.3 Middle East & 21.6 32.3 19.4 Anderson et al. (2008). North Africa 11.9 12.1 11.8 The combined impact of these trade-distorting South Asia 19.5 46.4 18.2 14.0 31.4 13.2 agriculture policies has been to displace and Sub-Saharan 14.4 24.9 12.9 reduce the efficiency of agriculture production Africa 8.4 13.8 7.6 globally ­ and particularly in the developing Note: TTRI in italics; OTRI in boldface font. world. While trade measures are introduced for a Source: World Bank (2008b). wide range of domestic motives (for example, economic, social, environmental, security), they In addition to trade barriers, many developing are mostly welfare reducing--both in the countries, especially low-income countries, have country applying them and in the rest of the had agricultural policies that effectively taxed world--relative to direct first-best policy their farmers. The extent of taxation measured instruments for achieving those domestic by nominal rates of assistance (NRAs) was of objectives (Bhagwati 1971). In distorting the the order of 20 percent from the mid-1950s to incentives producers and consumers would the mid-1980s. Since then it has not only otherwise face, they are also welfare- diminished, but, on average, has become slightly redistributing and inherently discriminatory. By positive (figure 2). In Africa there has been the promoting less efficient production in developed least tendency to reduce the taxing of farmers-- countries at the expense of investment in the average NRA has been negative in all 5-year generally more efficient production in periods except in the mid-1980s when developing countries, both global agriculture international prices of farm products reached an production and world food prices have been kept all-time low in real terms. While taxing artificially low, and domestic food prices in agriculture has been detrimental to farmers (and protected markets have been kept artificially 3 TRADE NOTE July 24, 2008 high. Policies in developing countries have, until restrictions usually have major adverse recently, generally taxed agriculture to channel economic and social effects because they tend to resources into manufacturing, with the result that (1) distort prices and the allocation of resources, investment in increasing supply has not been therefore impeding investment and the supply- adequate to provide for rapid responses to global side response; (2) prevent local farmers from price spikes. Furthermore, because agricultural receiving the higher world market price for their production has taken place in relatively production, therefore slowing the reduction of inefficient, thin, and insulated markets, global poverty in rural areas where most poor people trade in food products is less resilient to live; (3) displace local production to crops that exogenous shocks and less able to handle are not subject to export restrictions, therefore volatility in terms of trade and output. aggravating the very food security and price concern that justifies the measure in the first More recently, biofuel policies in high-income place; (4) cut local production from global countries, which consist of import duties, buyers and distribution chains, therefore subsidies, tax credits and legislative mandates, jeopardizing future reentry in once-secure have had the effect of further distorting global markets; (5) create space for illegal trade, agricultural trade and contributing to the global therefore fuelling corruption and other food price crisis. Biofuel production in the governance malpractices; (6) exacerbate the rise United States from food crops such as maize and and fluctuations of global food prices, therefore soybean oil and in the EU from rapeseed and creating a vicious incentive for trading partners sunflower seeds oil have fuelled the rise in food to follow suit, curb exports, and hoard; and (7) prices by increasing the demand for these food harm the multilateral trading system, therefore crops and shifting land out of other crops. In the weakening the security of poor and vulnerable last three years, 5 million hectares of cropland countries. As more countries implement export that could have been used for wheat have gone controls, world prices go up substantially--up to to rapeseed and sunflowers for biofuels in major 20 percent--due to export restrictions, with wheat producers, including Canada, the EU, and particularly harmful effects in the case of rice the Russian Federation. Biofuels have absorbed (Ivanic et al. forthcoming). virtually all of the increase in US corn production in 2004-2007, the period of The surge in global food prices has its origins in accelerated increases in maize prices. The US is long-term policies that led to thin and potentially the main supplier of the global market (Mitchell, volatile markets with diminished resilience, 2008). Increased demand for biofuels is especially in the South. Then, the sudden estimated to account for 70 percent of the emergence of other factors ­ energy price increase in corn prices and 40 percent of the increases and demand for biofuels, drought, and increase in soybean prices (IMF 2008). Though short term policy responses -- provided the spark oil prices may have been somewhat higher in the for today's crisis. absence of these biofuels, these subsidies do not promote economic efficiency as an offset to their Looking Forward: Trade Policy Options inflationary impact. Trade policy options to deal with the crisis involve correcting these historical distortions. Lastly, the introduction of export restrictions on They include removing export controls on agricultural products by many large net food agricultural products, eliminating restrictions on exporters has compounded the crisis. The humanitarian food aid, reducing excessive world's major non-OECD exporters of wheat stocks of food grains, reversing biofuel subsidies (that is, Argentina, Ukraine, Russia, and and protection to inefficient producers, lowering Kazakhstan) and rice (that is, Vietnam, India, customs duties on agricultural products, and China) have introduced various types of facilitating agriculture trade, completing the temporary export restrictions in an attempt to Doha round of trade negotiations, and, in the decouple domestic markets from global markets long run, further liberalizing agricultural trade and rein in domestic food prices. These on a multilateral basis. Many importing 4 TRADE NOTE July 24, 2008 countries have already embarked on this agenda confronted with them perversely bolsters the by slashing tariffs to lower the costs in their argument that net food importers need to have domestic markets. the ability to support farmers through restrictive trade policies. In the absence of reliable world Eight Ways to Make the Future Better markets for food products, a country cannot help Pressure on food supplies and associated high but self-insure and support its own farmers. food prices are likely to be a medium- to long- term reality, because some of the driving 2. Eliminating taxation or restrictions factors--rising prosperity in the developing on humanitarian food aid. world, which creates more demand; high fuel prices; stagnant agricultural productivity; and Untying food aid would allow countries such as climate change­induced pressure on agricultural the United States, Canada, and Germany to supplies--are also durable. While the policy significantly increase their assistance for a given response to the current crisis must involve much amount of financial resources (Subramanian more than trade policy (World Bank 2008a), a 2008). If the tying requirements were number of trade policy options could help eliminated, just the savings from increased mitigate the impact of the crisis, both in the shipping and distribution costs would allow short term and in the medium to long run. every dollar of food aid to go much further (Elliot 2006). Clear rules should be set so that 1. Removing export bans and other even countries with restrictions on commercial export restrictions on agricultural exports allow food for humanitarian needs to be products sourced from their country. Restrictions on procuring food grains for humanitarian purposes While exports restrictions are introduced as an have been particularly detrimental. attempt to address the complex political economy of rising food inflation, they only 3. Reducing excessive stocks of food make matters worse both from a global and grains. domestic perspective (Nogués 2008). In the case of the thinly traded rice market, the impact of Japan currently has roughly 900,000 tons of U.S. these restrictions has been especially strong. medium grain rice and 600,000 tons of long India's decision last October to ban rice exports, grain rice imported from Thailand and Vietnam, except for Basmati, was quickly followed by which are surplus to domestic consumption Vietnam and other major players, with an requirements based on its World Trade immediate impact on prices. Actions by large Organization (WTO) obligation. However this rice importers, such as the Philippines, which rice may not be reexported because of Japan's organized large tenders to obtain needed rice market access commitments under the WTO imports against this background of shrinking Agreement on Agriculture. These stocks are not traded supplies, aggravated the problem. sold domestically; instead they are allowed to Reversing these policies would significantly decay and then used as livestock feed. Last year ease market pressure and reduce the price of about 400,000 tons of rice was disposed of in rice. For example, when Ukraine announced that this manner. Temporarily allowing Japan to sell it would relax its export restrictions in April its stocks commercially or as food aid could 2008, wheat prices immediately declined by 18 make a significant difference and prick the percent. An international call has been made for current rice price bubble. China is also holding removing all export bans and restrictions on rice stocks equal to at least four months of food products, at the very least for shipments to domestic consumption (significantly in excess of the least developed countries and those in fragile food security guidelines of 18­20 percent of situations (Zoellick, 2008). Furthermore, the total consumption) and could help stabilize the need to discipline export restrictions is all world rice market without affecting its food the more important as the prospect of being security. 5 TRADE NOTE July 24, 2008 4. Curbing subsidies and tariffs on net-food importing countries, transport and European Union (EU) and U.S. logistics costs are often a more important biofuels production and imports. component of total trade costs than tariff barriers. Their logistics costs could amount to up Phasing out biofuel policies that subsidize to 50 percent of the import value, compared with production from food crops, such as corn and the Organisation for Economic Co-operation and vegetable oils, and reducing tariffs that restrict Development (OECD) benchmarks of around 9 imports from lower-cost producers would percent. The situation is particularly severe in promote biofuels that are both more efficient and landlocked countries, notably in Africa, where less competitive with production of staple foods land transportation adds significantly to logistics (that is, sugar cane). It would remove pressure costs (typically US$ 10 cents per ton and from food prices and allow the potential benefits kilometer). This could double the shipping of biofuels to be gained without the negative charges from overseas sources, which for high consequences. Biofuel production from sugar volume, relatively low value goods such as cane in Brazil is both competitive at current oil grains and edible oils could represent a prices without the need for subsidies and does significant part of the final price to consumers. not come at the expense of shifting large While countries can do little to reduce ocean amounts of land away from staple foods. It is shipping costs, or the impact of fuel prices on also five times more efficient in terms of carbon trucking costs, they have substantial margin for emissions than biofuel from corn. This is an improving the efficiency of their supply chain opportunity not just for Brazil, but for many and addressing the broader facilitation issues other developing countries, including several in that affect price and availabilities of food Africa (for example, Mozambique, Tanzania) deliveries. According to the World Bank's that are very large potential efficient suppliers of Logistics Performance Index, customs sugar cane biofuels. clearances, logistics, competence of services, and timeliness are particularly poor in LICs, in 5. Reducing import tariffs on particular net-food importing countries. In many agricultural products. LICs, food products are often subjected to a series of delays, unnecessary overhead costs, Many countries that had relatively high import and losses and damages that further tax tariffs on wheat, maize, and/or rice until the consumers. Furthermore, thin markets and weak recent food price surge have reviewed and competition and governance encourage rent- significantly reduced their duties on food seeking behaviors. In some African trade products in recent months to cut food costs to corridors, distribution margins have been local consumers. However, such revisions, at inflated by 30 percent on top of increasing times, appear to have been ad hoc, to lack transportation prices. transparency, and to lead to uncertain effects on the actual level of protection and domestic food 7. Completing the Doha round of prices. Tariff cuts should to the extent possible multilateral trade negotiations. be made in the context of a broader tariff schedule reform. Countries where high import While the WTO cannot provide anything duties still apply (for example, rice in the immediate to help solve the current crisis, it can, Philippines) should consider reducing their through the Doha Round negotiations, provide tariff, especially when they have the fiscal space. medium- to long-term solutions (WTO 2008). A Doha deal is unlikely to have much, if any, 6. Facilitating agricultural trade in impact on food prices in the next two or three developing countries. years because implementation of its provisions is gradual and because the long-run impacts on Beyond tariff cuts, many developing countries prices of staple foods would be modest since could reduce the price of imported agricultural many countries have now reduced applied rates products through trade facilitation measures. For below bound rates, the target of Doha many low-income countries (LICs), especially negotiators. Nonetheless, a successful Doha 6 TRADE NOTE July 24, 2008 round would place important disciplines on the at the global level, they push up world prices use of agricultural subsidies and tariffs if and even further and hurt net importers. From a when prices eventually do come down and the global perspective, maintaining free trade in temptation to revert to the distorting policies of commodities while fostering incentives for the past reemerges. Completion of the round production and using efficient policies to protect would therefore represent a major step in the the urban poor (for example, targeted cash right direction. It would help create a more transfers) is a priority. WTO members would transparent, rules-based, and predictable food therefore need to make more substantial cuts to trading system. In particular, a Doha agreement their bound tariff rates and domestic farm would eliminate export subsidies and may support commitment to seriously begin to somewhat reduce domestic farm support for eliminate global distortions. Some of these are inefficient production in developed countries. now being achieved unilaterally with the Tariff bindings, even if above applied duties, reductions in tariffs in many importing would allow cutting tariff peaks, which are often developing countries. More importantly, the the most costly, while reinforcing predictability benefits of freer global trade would go way of the trading system. Such efficiency gains in beyond the positive impact on food and changes agricultural production may provide incentives in food prices. For low-income countries, they to promote investments in the agriculture in will result in higher real incomes as other developing countries. A Doha agreement could (nonfood) distortions are removed and more also add some transparency disciplines on the opportunities are created in nonfood agriculture use export restrictions in enforcing the (for example, for cotton farmers, for sugar notification of new export restrictions or producers to satisfy ethanol demand), prohibitions to the WTO; and minimal manufacturing, and services. disciplines on the period of application of these restrictions or prohibitions. A better functioning Conclusion multilateral trading system would in turn help The most effective trade policy response to high prevent the recurrence of such types of crisis by food prices over the long term is greater reducing the magnitude of distortions for liberalization around the world that would allow agricultural production and making agriculture new supplies to emerge, particularly in markets more resilient. Current high food prices developing countries. This can only occur should make it politically easier to strike a deal through greater commitment to multilateral trade that would require farmers in rich countries to rules that discipline border barriers, domestic adjust. Negotiations in the area of non- support, and export subsidies. Progressively agricultural market access (NAMA), services curbing the use of trade policy to interfere with and trade facilitation could also have positive market signals--on both the export and import impacts on national transport and infrastructure, side--is the most sustainable and inclusive food distribution systems, and marketing costs policy option available to trade policy makers to for food and food inputs, especially if supported create more efficient and resilient agricultural by a strong Aid for Trade program. markets. 8. Beyond Doha, further liberalizing Trade policy is usually an ineffective instrument agriculture trade would help. to improve income distribution or to provide food security and rural development. This is not In the longer run, taking steps toward fully just because trade policy distorts consumption liberalizing agriculture trade on a multilateral and production decisions but also because the basis would help establish a more efficient and distributional consequences of protecting resilient global agriculture sector. Restrictive agriculture may be harmful to many poor trade policies by net commodity exporters to households, especially those that are net protect the urban poor tend to have unintended consumers and do not derive income from negative consequences at the domestic level, and agriculture. 7 TRADE NOTE July 24, 2008 This means that trade liberalization, to be effective, needs to be complemented by other OECD (Organisation for Economic Co- domestic policies aimed at increasing operation and Development). 2007. Agricultural agricultural productivity, linking rural Policies in OECD Countries: Monitoring and communities to markets, and ensuring that poor Evaluation. Paris: OECD. benefit from trade liberalization. While emphasis varies from country to country, these Subramanian, Arvind. 2008. Statement before policies broadly include ensuring an adequate the U.S. House of Representatives, Committee investment climate as well as making specific on Financial Services, hearing on Contributing investments in agriculture, such as market Factors and International Responses to the extension, rural roads and other infrastructure, Global Food Crisis, May 14, 2008. and agricultural technology (see World Bank, 2008c). In an era of climate change, investments World Bank. 2008a. "Addressing the Food in agricultural security through improved Crisis: The Need for Rapid and Coordinated weather forecasting, monitoring, and Action." Group of Eight, Meeting of Finance preparedness are also required to avoid Ministers, Osaka, June 13­14. catastrophic losses. World Bank. 2008b. Global Monitoring Report. References Anderson, Kym, Marianne Kurzweil, Will World Bank, 2008c World Development Report, Martin, Damiano Sandri, and Ernesto Agriculture for Development, World Bank: Valenzuela. 2008. "Measuring Distortions to Washington Agriculture Incentives, Revisited." Policy Research Working Paper 4612, World Bank, Zoellick, Robert, Statement to the Rome Food Washington, DC. Summit, June 3, 2008. Bhagwati, J. N. 1971. "The Generalized Theory WTO (World Trade Organization). 2008. Statement by of Distortions and Welfare." In Trade, Balance Pascal Lamy at the Rome Food Summit, June 3, 2008 of payments and Growth, ed. J. N. Bhagwati et al. Amsterdam: North-Holland. I am grateful to Jean-Francois Arvis, Mona Haddad, Bernard Hoekman, Mariem Malouche, Will Martin, and Elliott, Kimberly Ann. 2006. Delivering on Richard Newfarmer for useful comments on an earlier Doha: Farm Trade and the Poor. Washington: version of this draft. Peterson Institute for International Economics and Center for Global Development This trade note has also been published in two parts as World Bank PREM Notes. IMF (International Monetary Fund). 2008. Remarks by John Lipsky, First Deputy Managing Director, International Monetary Fund, at the Council on Foreign Relations, Commodity Prices and Global Inflation, New York City, May 8, 2008. Ivanic, Maros, Will Martin, Aaditya Mattoo, and Arvind Subramanian, forthcoming. Mitchell, Donald O. 2008. "A Note on Rising Food Prices" World Bank, mimeo April 8. Nogués, Julio. 2008. "Socio Economic and Fiscal Impacts of Policy Barriers on Argentine's Agro-Industrial Exports." Draft mimeo. 8